2008): "Liquidity traps, learning and stagnation

We examine global economic dynamics under learning in a New Key-nesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to ex-pectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal poli-cies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals. JEL Classification: E63, E52, E58